- Posted by: admin
- Category: English
Have you ever wondered where people buy financial products?
I mean, it’s not like buying a pair of jeans, right? You can’t just try them on for size.
That is where the capital market comes in.
The financial market is a world where new securities are issued regularly. It is a world of varied financial products, tailored to the needs of every individual from every income bracket. These financial products are bought and sold on the capital market, which is divided into the primary and secondary markets.
I’m sure you’ve heard the words primary market before.
I mean, it’s not a very uncommon or complicated phrase.
But do you know exactly what a primary market is or why it is called a primary market?
Don’t worry, it’s very simple.
A primary market is one that issues new securities on an exchange for companies, governments and other groups trying to obtain financing through debt based or equity based securities. It is also called the new issue market.
Let’s break it down.
The main players in the primary market are the private and public companies that offer equity or debt based securities such as stocks and bonds in order to raise money for their operations. They sell their securities to the public through an Initial Public Offering or IPO. The securities here are bought directly from the companies.
Now, this all sounds fine. But who takes the decisions in a market like this?
I mean, this is not exactly your garden variety shopping mall, right?
Investment banks are the main underwriters in the primary markets and are thus the major facilitators of these types of markets.
What this means is that investment banks are the ones who decide the base price of the securities on sale and then administer the entire process of the sale to the investors.
The underwriters are also the ones who play the important role of safeguarding the issue related risks for the company that is offering its shares for sale.
In short, they are the ones in charge.
As I mentioned before, primary markets are not really like shopping malls where you can browse through the shops, try the products on for size before finally deciding what looks flattering.
So how does one buy or sell in a market of this sort?
Normally, the entire process of buying a primary market security involves several rules and regulations that have to be properly adhered to before the act of sale can take place.
IPO is one of the integral processes of the primary markets. Through an IPO, a company announces the sale of its securities at a starting price.
Investors can obtain news of upcoming shares only in the primary market. The issuing firm collects the money, which is then used to finance its operations, or used in the expansion of business, by selling its shares. Before selling a security on the primary market, the firm must fulfill all the requirements.
After trading in the primary market, the security enters the secondary market where numerous trades happen everyday.
The next obvious question is,
What are the methods of trading securities in the primary market?
There are four methods of raising capital or equity through the primary market.
- Public Issue: As the name suggest, public issue means selling securities to the public at large, such as IPO & FPO (follow-on public offer).
Investopedia explains FPO this way:
It is the most vital method to sell financial securities.
2. Rights Issue: Whenever a company needs to raise supplementary equity capital, the shares have to be offered to the present shareholders on a pro-rata basis. This is known as rights issue.
3. Private Placement: This is about selling securities to restricted number of investors like venture capitalists, mutual funds, banks, etc.
4. Preferential Allotment: When a listed company issues equity shares to a selected number of investors at a price that may or may not pertain to the market price, it is known as a preferential allotment.
Features of the primary market:
Primary markets tend to be more unstable as compared to the secondary markets. The reason for this is that it is difficult to assess the levels of demand for a security among investors before a few days of trading.
Aside from the obvious reason of their importance for businesses, primary markets are important because they help create capital.
Now that I’ve discussed the primary market at depth, (and bored you, I’m sure), let’s move to the secondary market.
Meaning of Secondary Market:
The secondary market is where investors buy and sell securities they already own. When you picture a stock market, what you’re actually thinking of is the secondary market. The defining character of the secondary market is that the investors trade among themselves.
The securities are first offered in the primary market to the general public for a subscription where the company receives the money from the investors and the investors get the securities. After this, they are listed on the stock exchange for further trading. These stock exchanges are the secondary markets where the major part of trading is done. Money and securities are transferred between investors in the secondary market. The top two stock exchanges in India are the Bombay Stock Exchange and the National Stock Exchange.
Differences between the primary and secondary markets:
I’ve tabulated the differences between the primary and secondary markets to help visualize it better.
|BASIS FOR COMPARISON||PRIMARY MARKET||SECONDARY MARKET|
|MEANING||The market place for new shares||The place where formerly issued securities are traded again|
|ANOTHER NAME||New Issue Market||After Market|
|TYPE OF PURCHASING||Direct||Indirect|
|FINANCING||It supplies funds to budding enterprises and also to existing companies for expansion and diversification||It does not provide funding to companies|
|NUMBER OF TIMES A SECURITY CAN BE SOLD||Only once||Multiple times|
|TRADING BETWEEN||Company and investors||Investors|
|WHO GAINS THE AMOUNT ON THE SALE OF SHARES?||Company||Investors|
|PRICE||Fixed price or specific price band||Price fluctuates depending on demand and supply|
|ORGANISATIONAL DIFFERENCE||Not rooted to any specific spot or geographic location||It has physical existence|
That is about all I had to tell you about the secondary market. It might also pique your interest to know that there is something called the third and fourth market as well. They aren’t heard of publicly, though.
The third market caters to transactions between dealers or brokers and large financial institutions. The fourth market is only about transactions between large institutions. The activities of these markets have little or no influence on the workings of the usual stock trading by an average investors.
You might be wondering what the point of these markets are, right?
I mean, why have I been spending all this time explaining these concepts to you?
I’m glad you asked.
The two financial markets play a major role in the mobilization of money. This is beneficial for the country’s economy.
The primary market encourages direct interaction between the company and the potential investors. On the other hand, in the secondary market, brokers help investors trade securities with other investors.
So, you see, I’m not completely crazy. I haven’t been feeding you useless information. It’s very important to know about the capital markets because they are integral to the functioning of a country’s economy. If you would like to add something, or leave a comment, please feel free to do so.